I thank the committee for the invitation to attend this meeting. We have been asked to make this initial presentation on the third Mazars report on lending to SMEs. The report has been produced at the request of the Department of Finance and the credit supply clearing group, a group established by the Department of Enterprise, Trade and Employment in May 2009. The members of the credit supply clearing group are the Department of Finance, the Department of Enterprise, Trade and Innovation, Enterprise Ireland, Forfás, the Irish Banking Federation, a number of banks and representatives of business groups, including ISME and the SFA. Our involvement in the SME lending process and the type of data we were requested to report on was agreed by the clearing group at the beginning of the first Mazars reporting process.
The reports have their origin in the bank recapitalisation programme of February 2009, under which the recapitalised banks agreed to facilitate an independent review of lending to SMEs. Our initial report on SME lending was published in June 2009, it was followed by the second Mazars report in December 2009 and the third in April 2010. Five banks participated in all three reports — Anglo, AIB, Bank of Ireland, National Irish Bank and Ulster Bank. The trends and patterns in lending to SMEs are relatively consistent across all three reports in terms of the demand for credit among customers and the supply of credit by banks. Mazars role in the reporting process is that of an independent party with responsibility for the review, collation and analysis of data. All reports have been produced in a similar and consistent manner and have been accepted by the credit supply clearing group to which they were presented. The reports have been published by the Department of Finance.
The first and second Mazars reports included an analysis of both the demand for credit, by way of a large customer survey, and the supply of credit, by way of analysis of bank data. The first report also included an examination of credit policy, credit pricing and credit terms and conditions. The third report, which is the focus of our discussion today, included an examination of the supply of credit only — an analysis of bank data.
The report examines the supply of credit under a number of product headings, namely, loans, overdrafts, finance and leasing products and invoice discounting. These are the products included in the Financial Regulator's code of conduct for lending to SMEs published in February 2009. Our report examines real economy activity so we have excluded a number of sectors or sub-sectors that are not representative of real SME activity, such as pension schemes, speculative construction and private householding lending, etc.
I would like to give the committee an idea of how we approached this exercise. At the outset of this reporting process, we conducted an analysis of what information was available within individual banks and what could be reported on. We presented that information and associated options to the credit supply clearing group, and between that group, Mazars, the Department of Finance and the Irish Banking Federation, we agreed the report should examine a number of issues regarding the supply of credit. These include exposure, which is the total value of lending currently extended to SMEs across all products. Credit applications refers to the number and value of formal credit applications received by the banks. Approvals and declines are the number and value of formal credit applications approved and declined by the banks. Overdrafts, limits and utilisation were considered because they are important in the context of the working capital need of SMEs. We reported the level of overdrafts used and available. Credit quality refers to the extent to which SMEs credit facilities are repaying or in difficulty. Drawdown is the value of credit drawn down in the period and flowback is the rate at which total lending is being repaid on an ongoing basis. The systems in the banks have not been designed to support the type of analysis we are trying to do in this exercise. This is particularly true of credit applications. We experienced a number of limitations in our efforts to report certain types of data.
Our third report on lending to SMEs showed that lending at €32.3 billion has reduced only marginally by some 1.2% as compared with the third quarter of 2009 and 3.6% as compared with the fourth quarter in 2008. Lending with regard to loans accounts for over 80% of total lending and this category has experienced the smallest reduction in the last quarter of 2009. The largest percentage reductions in lending, although small in value terms, are apparent in finance and leasing and invoice discounting. This is not unusual on the basis that finance and leasing products are generally used to buy capital equipment or machinery or fund similar capital investment. These are activities that are reduced in a recession.
We did not conduct a separate demand survey as part of this report but we examined the level of credit applications banks are receiving from customers. Our analysis of credit applications looked at formal applications only as this is the information banks capture. This refers to applications recorded on banks systems, not inquiries, and this tells us that applications for credit decreased by 36% as compared with the same period last year but increased by 5.6% in the fourth quarter of 2009 as compared with the third quarter in 2009. This may reflect a seasonal demand for credit in the last quarter of 2009.
Applications for loans and overdrafts showed a slight increase of 2% in the quarter. The main reason for the overall increase was a significant increase in demand for finance and leasing products. This may be due to seasonal factors. However, credit applications across all products are significantly down compared with the same period in 2008. We started to collect data in June 2008. Credit applications have fallen by half since that date. This tells us that SMEs are, for whatever reason, making fewer applications for credit to banks than previously.
I refer to approval and decline rates. Over 29,000 applications for credit, with a value for some €1.6 billion, were approved in the fourth quarter of 2009. This is higher than in the third quarter of 2009 but significantly lower than the same period in 2008. The approval rate based on the data reported by the banks is 87.5%. It shows a small improvement on previous periods. However, in our report, we expressed some concern over this figure, and our opinion is that an approval rate of 84% or a 16% decline rate is more representative of the position. Our equivalent opinion in the second Mazars report was 82%. This difference results from differences in bank systems and the way they record credit decisions and limitations in the way applications are captured. We performed some additional work to try and smooth out the impact of these limitations but it was not possible in all cases. These patterns of approval and decline are relatively consistent across all three Mazars reports. If they are compared to the demand for credit on the customer side, which in previous reports was based on a large survey of customers, a decline rate of approximately 24% was apparent in the first Mazars report and 28% in the second. Therefore, there is a difference of approximately 10% or 12% between the supply on the bank side and the demand on the customer side. That difference has been relatively consistent across all Mazars reports where a customer study was undertaken.
I will move on to other key lending indicators and look first at drawdowns. Our report shows that SMEs have drawn down or used approximately €1 billion of new credit in the quarter. This €1 billion equates to a monthly figure of about €356 million, as compared to a monthly figure of €377 in the previous Mazars report. With regard to overdrafts, these are a critical form of working capital finance for SMEs. It is apparent that at December 2009, overdraft levels have fallen slightly, by approximately 1.4% as compared to the second Mazars report. However, significant capacity in unused overdrafts is still apparent at end-2009. There is approximately €2.6 billion of unused capacity in overdrafts or 48% of approved limits as at December 2009.
Flowback relates to the rate at which total lending is being repaid by customers on an ongoing basis. Our report indicates that it is clear that by December 2009, SMEs were attempting to repay their debts. Repayments to banks were greater than drawdowns from banks in the three months to December 2009. Therefore, because of that, flowback has decreased from 5.5 years to 5.2 years, which means that, on average, SME credit will be repaid within a period of 5.2 years.
We also examined the quality of the SME loan book. This examination was carried out by examining how the SME loan book is split by credit grade within the participating banks. Each bank maintains and is required to maintain a grading system for its customers, whereby a customer or credit facility is assigned a credit grade based on a number of factors, such as business or financial risk, repayment capacity and so on. We have categorised those grades into three grades, performing loans, which are loans to SMEs which are making repayments, watchlist loans, which relate to accounts which are between 30 and 90 days overdue and impaired loans, which are accounts which are 90 days or more overdue.
Following our examination, it is clear that there is continued distress in the SME loan book. This is clearly shown in the dashboard or chart in our report. The green part of the column represents performing accounts, the orange part represents watchlist accounts and the red part represents impaired accounts. It can be seen that the green area — the performing loans — has reduced greatly in recent periods, but that the orange and red have increased. This tells us that by December 2009, the green or performing section seems to have stabilised somewhat but that watchlist and impaired accounts continue to deteriorate. The chart shows too that in December 2009 approximately 35% of the SME loan book would appear to be overdue. Of particular note is the level of increase in the red or impaired category by December 2009, which had increased by 5% on the previous quarter, which is quite significant.
It is important to consider SME lending in the context of economic trends and we have attempted to do this in our third report. We examined SME lending as compared to overall lending in the economy. This examination showed that lending to SMEs is falling, but at a slower pace than overall lending in the economy. Overall lending has fallen by approximately 16%, if we remove construction, and SME lending has fallen by approximately 4.5%. We also looked at the level of applications for credit within the banks, as compared to other demand factors, such as the demand for goods and services represented by GNP and the retail sales index. Demand for credit applications has fallen by approximately 50% since June 2008, which represents a significantly greater fall than the overall demand for goods and services.
We spoke earlier about credit quality and I demonstrated that at December 2009, some 35% of the SME loan book was experiencing difficulty. If this is compared to other indicators of economic difficulty, such as insolvency and unemployment, it is clear that the repayment capabilities or credit quality of SMEs closely tracks the larger deterioration of the economy as a whole. All of these parameters will have doubled in the past 12 months.
The three Mazars reports prepared to date have been prepared at the request of the Department of Finance and the credit supply clearing group established by the Department of Enterprise, Trade and Innovation. Our role in the reporting process is that of an independent party with responsibility for the review, collation and analysis of data. The first Mazars report also involved the detailed review of systems and processes in the banks participating in the exercise to allow us establish a sound and reliable basis for the ongoing reporting of lending to SMEs. The systems within the banks have not been designed to support the type of analysis we are trying to conduct in this exercise. While we have experienced limitations in our efforts to report certain types of data, we have attempted to overcome these limitations, but it was not possible to do so in all cases.
The third Mazars report shows that lending to SMEs has decreased very slightly in quarter four of 2009, but that while credit applications have decreased by more than 50% since last year, more than 29,000 applications for credit, with a value for some €1.6 billion, were approved in the last quarter of 2009. There is continued distress apparent among SMEs, with 35% of the SME book operating outside its repayment obligations. This would suggest that more than one-third of SMEs, at a minimum, have significant cash flow difficulties and do not have the capacity to either apply for or secure additional credit. This is the most significant figure emerging from the third Mazars report.
